Bulletin – September 2018
Australian Economy
The Effect of Minimum Wage Increases on Wages, Hours Worked and Job Loss

Abstract

Australia has a detailed system of ‘awards’ that specify different minimum
wages depending on the industry, location and skill of an employee. I find that
legislated adjustments to award wages in Australia between 1998 and 2008 were almost
fully passed on to wages in award-reliant jobs. There is no evidence that modest,
incremental increases in award wages had an adverse effect on hours worked or the job
destruction rate.

The effects of minimum wages on employment have been widely debated internationally. Economic
theory makes no clear predictions: although the traditional competitive model of the labour
market suggests that a minimum wage rise will reduce employment – if set above the market
clearing wage – other theoretical models can predict the opposite. For example, an
increase in the minimum wage could increase employment in a labour market where firms
have some degree of market power that allows them to set wages (e.g. Card and Krueger (1994)).
Empirical evidence for other countries has been varied, depending on the methodologies and
datasets used but, on balance, suggests that modest and incremental increases in minimum wages
do not have significant adverse effects on hours worked and job loss. There has been limited
empirical evidence for Australia, partly because of data constraints. This article contributes
to the debate by using an approach and a job-level dataset that are uniquely suited to studying
the effects of minimum wage increases in Australia.

The analysis focuses on the minimum wage changes most common in Australia: annual adjustments by
the Fair Work Commission (FWC).[1]
These adjustments have typically been modest, incremental and, to some extent, predictable. The
analysis finds that these changes are almost fully passed on to wages in award-reliant jobs, and
appear to have had little adverse effect on hours worked or job loss. These findings are
consistent with the international evidence and the FWC's (2018) current assessment of that
evidence. However, the findings do not necessarily generalise to large, unanticipated changes in
minimum wages.

Minimum Wages in Australia

The National Minimum Wage (NMW) sets a legal floor on wages. As of 1 July 2018, this was equal
to $18.93 per hour for an adult employee. Australia also has a detailed system of award wages
that are layered on top of the NMW. These ‘award wages’ can depend on the industry,
age, skill level and qualifications of an employee, among other factors. For example, an
employee who supervises lift operators at a ski resort is entitled to a wage of $24.63 per hour,
30 per cent above the NMW. As such, while many ‘minimum wage’ employees
are paid the NMW – particularly lower-skilled workers and those not covered by an award or
enterprise agreement – many others are entitled to a higher wage.

The NMW and all award wages are adjusted at the same time every year, usually in early July. The
size of these adjustments is decided at a national level by the FWC. Any adjustments are applied
consistently across awards; historically the FWC has either added a flat dollar amount to all
award wages (1993–2010) or raised all award wages by the same percentage amount (2011–18).
Adjustments to individual awards are less common. In its recent Annual Wage Review, the FWC
announced a 3.5 per cent increase in the NMW and minimum wages across all awards,
which took effect on 1 July 2018 (Graph 1).

Graph 1

Australia's system for setting minimum wages is more complicated than in most other
countries. Unlike other countries that set a single minimum wage (e.g. the United Kingdom,
Germany and New Zealand) or a minimum wage that varies by state (e.g. the United States), the
Australian system has thousands of award wages that currently range from $18.93 per hour to as
high as $171.00 per hour (Graph 2). Because award wages are often set above the NMW, the share
of Australian employees whose pay is set according to a minimum wage is relatively high by world
standards. Nearly one-quarter of all employees in Australia have their wage set according to a
minimum or award wage, and this share has risen over recent years (RBA (Reserve Bank of
Australia) 2017). The large share of employees affected by FWC decisions also reflects that the
NMW in Australia is high relative to other nations, both in absolute terms and as a share of
median earnings (Productivity Commission 2015a).

Graph 2

The Effect of Minimum Wages on Employment

Australia's unique institutions for setting minimum wages mean that the findings of
empirical studies for other countries do not necessarily apply in the Australian context. The
complexity in Australia's wage-setting institutions also makes estimating the effects of
minimum wages using Australian data a difficult task.[2]

The main challenge in estimating the effect of minimum wages on employment is that it is hard to
disentangle the effects of minimum wages from the effects of everything else that is going on in
the labour market. For example, if minimum wages are adjusted at the same time as a change in
income tax rates, then any change in employment that occurs around the change in minimum wages
may in fact be due to the tax changes rather than the FWC decision. To isolate the effects of
the minimum wage changes on employment, we need to consider a group of workers who are affected
by the change and another group that are not (i.e. a control group), but are otherwise subject
to the same forces affecting the economy and the labour market. The challenge for researchers is
that it can be difficult to find a suitable control group of individuals who are not affected
– or less affected – by the change.

I overcome this challenge by recognising that, while all jobs have their minimum wages adjusted
at the same time each year, historically, some jobs have had larger adjustments than others.
This means that we can compare the labour market outcomes of those receiving a relatively large
adjustment to those receiving a smaller adjustment.

The decade leading up to the late 2000s is particularly useful for studying the effects of award
wages on labour market outcomes. During this period, the FWC routinely granted flat dollar
increases to all awards each year, irrespective of the existing wage rates contained in those
awards. For example, in May 2000, the FWC increased all award wages by 39 cents per hour. This
meant that employees on relatively low award wages received larger wage increases in percentage
terms than those on higher award wages: a worker earning $10.14 per hour (the NMW at the
time) was entitled to a wage rise of 3.9 per cent, while a worker on $18 per hour
received an increase of only around 2 per cent (Graph 3). On some occasions, the FWC
also granted smaller flat dollar increases to higher award wage ranges, rather than a single
flat dollar increase. For example, in 2003, the FWC announced an increase of 45 cents per hour
for all award wages up to $19.26 per hour, and 39 cents per hour for all wages above this level.
This created a discontinuity in the profile of percentage wage increases at $19.26 per hour
(Graph 3). These discontinuities tended to exacerbate the differences in the size of the award
wage increase between low- and high-award-wage employees.[3]

This article uses these differences in the size of minimum wage adjustments across different
jobs to disentangle the separate effect of minimum wages from the effect of other changes in the
labour market. The idea is to simply compare the change in each variable of interest –
wages, hours worked or job loss – around each FWC decision between jobs that experienced a
relatively large percentage adjustment and those that only had a small adjustment.

Graph 3

Data

The approach described above requires detailed data on the wages and employment outcomes of
individual employees or individual jobs before and after each FWC decision. This article uses a
source of data not previously used in Australian research on minimum wages: job-level data from
the Australian Bureau of Statistics (ABS) Wage Price Index (WPI) survey. This survey includes
3,000 firms per quarter. Each firm is being surveyed every quarter for five years, before being
rotated out of the sample (roughly one-fifth of the sample is replaced each year). After being
selected into the sample, a firm is asked to randomly select a certain number of jobs from their
payroll records. The firm then reports information on each of these jobs over time. Around
18,000 jobs are included in the survey every quarter. Approximately 15–20 per cent
of these jobs have their pay set exactly according to an award.

A key advantage of this dataset is that it includes both a precise measure of actual wages and
an indicator for whether a job's wage is set according to a minimum or award wage. This
allows one to focus on jobs directly affected by minimum wage decisions. This approach differs
from most previous studies (particularly for the United States), which, due to data limitations,
tend to focus on low-wage industries, such as the restaurant sector, or on lower-productivity
employees, such as teenagers. Using low-wage groups as a proxy for employees reliant on minimum
wages may lead to biased estimates of the effect of minimum wages on employment (Jardim et al 2017). The WPI data also allow one to study the effect of changes to
minimum wages on hourly wages themselves, which is rarely possible with more traditional data.
The pass-through of award wages to hourly wages is a key consideration for the FWC in terms of
assessing whether firms are complying with their legal obligations. The elasticity of hourly
wages with respect to minimum wages is also one of the key parameters in assessing the effect of
minimum wage increases on income inequality (Leigh 2007).

The WPI survey follows jobs, rather than employees (for example, a graduate economist at the
Reserve Bank of Australia). If the occupant of the job leaves the firm or moves to a different
job within the firm, the ABS substitutes the job leaver with the employee who replaced her or an
existing employee with the same job title. For this reason, the results in this study pertain to
jobs, rather than individual employees. The estimation sample includes all private sector jobs
filled by an adult on an award rate. Juniors, apprentices and trainees are excluded from the
analysis, as their award wage adjustment cannot be inferred.[4] This is unfortunate because
these groups may be particularly vulnerable to job loss following an increase in award
wages.[5] This leaves
a sample of 32,174 job-period observations spanning the 11 FWC decisions over the period between
1998 and 2008.

Empirical Strategy

A difference-in-differences (DD) model is used to estimate the effects of minimum wage changes
on wages, hours worked and the job destruction rate of award-reliant jobs. The intuition for
this approach was discussed above; the DD model compares the change in each outcome variable
– wages, hours worked or job destruction – around each FWC decision between jobs
that experienced a relatively large percentage increase in their award wage and those that
experienced a relatively small increase. This means jobs that experienced a relatively small
adjustment to their award wages fulfil the role of a ‘control group’ for those jobs
that had a larger increase. The size of the award wage adjustment a particular job received is
inferred from its wage level immediately before the decision. Given that attention is restricted
to jobs paid exactly an award wage before each FWC decision, the results provide direct
estimates of the effects of minimum wages on award-reliant jobs.

Changes in wages, hours worked or job destruction around each FWC decision are measured from the
WPI survey immediately before the decision to the survey six months later. This gives valid
estimates of the effect of the minimum wage on wages, hours worked and job loss to the extent
that employers' adjustments to award changes happen within six months (Borland 2018). During
the period between 1998 and 2008, there were 11 minimum wage decisions. The approach taken here
is to pool the 11 decisions together and use a single DD estimator that constrains the
coefficient of interest to be constant across the decisions. This maximises the available sample
to estimate the effects of interest. The model includes controls for any macroeconomic shocks
that affect all wage groups and controls for any characteristics of each wage group that do not
change over time.[6]
Details of the model are provided in Appendix A.

The following outcome variables are considered:

Wages: the log of the job's hourly wage, excluding any wage changes due
to changes in the job occupant's grade or performance.

Hours worked: the log of the ordinary-time hours paid for during the most
recent pay period. This includes hours of paid leave (e.g. annual leave and sick leave) but
excludes overtime hours.

Job destruction rate: a binary variable that equals one if the job had
ceased by the survey date in question, conditional on the job existing six months earlier,
and zero otherwise. This captures both redundancies and firm failure, but does not include
cases where the job incumbent leaves the firm (either voluntarily or involuntarily) or if
the firm only makes some of the employees in a given position redundant.

The estimates for wages and hours worked are conditional on the job being in the sample in the
survey before and after a given FWC decision. If a job is vacant or made redundant in either
period, it is dropped from the sample for estimating the wage and hours effect. This is not the
case for the job destruction rate estimate.

Results

The estimates for wages, hours worked and the job destruction rate are shown in Table 1.
Separate estimates are presented using the full sample and a sample that omits the first four
FWC decisions (1998–2001). Although the sample size is larger for the full sample, there
is a data issue prior to 2002 that could potentially distort the regression results.[7]

Table 1: Effect of Award Wages on Wages, Hours Worked and the Job Destruction Rate(a)

There is strong evidence that award adjustments are passed on to wages. Using the full sample,
the elasticity of wages with respect to the award wage is estimated to be 0.84 and highly
statistically significant (Table 1). The estimate is larger in the shorter sample period (0.93)
which suggests that measurement issues in the first few years of data may be attenuating the
size of the overall elasticity in the full sample. A wage elasticity of 0.93 implies that a 1 per cent
increase in award wages leads to a 0.93 per cent increase in actual wages for
award-reliant workers. Full pass-through of minimum wage changes into wages would require this
elasticity be equal to one. Given the estimate is slightly less than one, it suggests
less-than-full pass-through of FWC decisions to wages.[8] This may reflect some degree
of noncompliance by firms in their legal obligations (see Productivity Commission (2015b, p 12)
for a discussion), or simply measurement error. In any case, the elasticity is sufficiently
close to one to characterise this as near-complete pass-through.

Having established that award wage increases are passed through to wages, the next step is to
see if this leads to any reduction in hours worked or job loss; this would be the case if the DD
estimates are negative for hours worked and positive for the job destruction rate. There is no
evidence that award wage changes have an adverse effect on hours worked or the job destruction
rate: in both cases the DD estimate is not significantly different from zero (Table 1). (And the
point estimates were in fact the opposite signs to an adverse effect.)

Robustness tests

Like any analysis using a DD approach, these results are sensitive to violations of the so
called ‘parallel trends’ assumption. The assumption is that, in the absence of a
change in award wages, the wages, hours worked and probability of job loss of low-award-wage
workers would have followed the same trajectory as high-award-wage workers. This would be
violated if, say, there is a change in tax policy that affects low-wage earners relatively more
than high-wage earners that occurs at the same time as the change in award wages. If this
happens, we may incorrectly attribute the effect of the tax change to the award wage. Bishop
(2018) discusses several ways of testing the validity of the parallel trends assumption. These
include placebo tests, using additional control groups, controlling for firm-specific shocks,
and accounting for ‘pre trends’ in the outcome variables. The results of these tests
suggest that the baseline estimates are likely to be robust to potential violations of the
parallel trends assumption.

Conclusion

There is widespread interest in understanding the effects of minimum wage increases. This
article adds to the evidence base by using an approach uniquely suited to Australia and a
dataset that provides several advantages over those used previously in the literature. It finds
that small, incremental adjustments to awards are mostly passed on to wages in award-reliant
jobs. These adjustments appear to have no discernible adverse effect on hours worked or job
loss.

There are several things to keep in mind when interpreting these findings. Firstly, as
discussed, these results are for adult employees only and do not include juniors. Secondly, the
results do not necessarily generalise to large, unanticipated changes in award wages. There will
always be some point at which a minimum wage adjustment will begin to reduce employment
significantly. Thirdly, the approach considers six month windows around FWC decisions; it is
possible that firms take longer to respond to changes in minimum wages. Finally, although this
article finds no evidence of an effect of award adjustments on job destruction, this does not
rule out an adverse effect on employment. It is possible that the adverse consequences of higher
wage floors may be borne by job seekers, rather than current job holders.

Appendix A The Difference-in-differences Model

where yikt is the dependent variable of interest for job i
in wage group k at time t. λt is a full set
of time dummies that control for any macroeconomic shocks that affect all wage groups in
any of the 22 time periods (there are 11 different FWC decisions each with their own
‘before’ and ‘after’ period).
FWCk is the log change in award wages for wage group k
due to the FWC decision. There are also a set of interactions between
FWCk and dt, the latter being a dummy that takes
the value of zero in the ‘before’ period immediately prior to an award
increase and a value of one in the ‘after’ period six months later. The
coefficient of interest is β3. When the dependent variable is
the log hourly wage (or log hours worked), this DD coefficient is the elasticity of
wages (or hours) with respect to the award wage, a parameter of key interest to
policymakers.

Footnotes

The Author is from the Economic Research Department. This article draws extensively on
Bishop (2018).
[*]

The FWC is an independent body with responsibility for adjusting minimum and award
wages. The FWC began operation on 1 July 2009 as Fair Work Australia, after assuming
responsibility for award wage-setting from the Australian Fair Pay Commission
(established in 2005) and the Australian Industrial Relations Commission before that. In
this article, ‘FWC’ is used to refer to any of the various national and
state industrial relations commissions with responsibility for setting award wages since
the late 1990s.
[1]

There have been several other Australian minimum wage studies. These studies often have
data or other limitations that make their findings difficult to interpret (see Borland
(2018) or Appendix C of Productivity Commission (2015a) for a review).
[2]

The only exception was in 2001, when the FWC awarded a series of larger flat dollar
increases to higher award-wage earners. Details on each decision are available in Bishop
(2018, Appendix A). Although the FWC had been announcing flat
dollar increases to all awards as early as 1993, this article focuses on the period
after 1998 due to data availability. It also omits the flat dollar increase announced in
2010 from the analysis as it may lead to results that are contaminated by the effects of
award modernisation. Since 2011, the FWC has announced flat percentage
increases to all awards each year (in addition to any adjustments associated with award
modernisation between 2010 and 2014).
[3]

Award wages for juniors, apprentices and trainees are set as a proportion of a relevant
adult classification in the award; as such, any percentage award wage adjustment for
these employees will be the same as the relevant adult classification. However, the size
of this adjustment cannot be inferred using WPI data because the relevant adult
classification for these groups is not available. Juniors (aged 20 years or younger)
accounted for 15 per cent of all employees on award wages in 2016 (ABS
(Australian Bureau of Statistics) 2017).
[4]

Jobs not within the scope of the federal industrial relations system after 2006 are also
excluded from the estimation sample, due to the uncertainty about what award wage
adjustments such jobs experienced during this period of industrial relations reform.
[5]

A wage group is defined as any job paid a certain wage. For example, all jobs paid $20
per hour will be one group.
[6]

This data issue relates to the fact that it is not possible to perfectly observe whether
a job was paid according to an award before 2002. For this period, it is only possible
to identify the job's pay-setting mechanism (e.g. award or enterprise bargaining
agreement) using procedures such as text searches for relevant keywords in the job-level
data, which can be error-prone. After 2002, the pay-setting mechanism was explicitly
coded in the dataset and therefore measured with less error.
[7]

The hypothesis that the wage elasticity is equal to one can be rejected at the 1 and 10 per cent
levels of significance using the 1998–2008 and 2002–08 samples,
respectively.
[8]

Borland J (2018), ‘A Review of Methods Applied in International Research on the
Employment Effects of the Minimum Wage and Implication for Australian Research’,
Fair Work Commission Research Report 4/2018, Fair Work Commission, Canberra.

Card D and Krueger (1994), ‘Minimum Wages and Employment: A Case Study of the
Fast-Food Industry in New Jersey and Pennsylvania’, The American Economic
Review, 84(4), pp 772–793.